The Brazilian stock has been rallying for the past five days with little coverage from the financial news outlets. The iShares Brazil ETF (EWM) is taking a breather today, but was up yesterday while the overall emerging markets (iShares Emerging Markets ETF, EEM) and the S&P 500 were trading down. EWZ has been up five days in a row for a total increase of over 8 percent. Year-to-date the Brazilian market has doubled the performance of the S&P 500 by being up over 10 percent. Once left for dead along with the rest of the emerging markets, the Brazilian ETF has rebounded 30 percent since its low in February.

The biggest day during the recent rally was on Friday, June 6. EWM increased by 3.3 percent. The news for the day was the declining approval rating for Brazil’s president, Dilma Rousseff, and the release of Central Bank meeting minutes. With the presidential elections coming up in October, Brazil’s Central Bank is likely to hold off on any interest rate changes. Currently the benchmark overnight rate, Selic, is at 11 percent, up from 7.25 percent in April of 2013. Inflation is currently at 6.37 percent and the GDP annual growth rate is at 1.9 percent.

Tony Volopon, head of emerging markets Americas for Nomura Securities in New York, says that we should not be fooled by rising inflation expectations, and the market has this one wrong. There is an expectation of rate cuts next year, and the probability of a cut will be greater if Rousseff loses the presidential election.

I decided to look to the gurus for guidance after seeing the rally in the Brazilian market. Using the GuruFocus All-In-One Screener, I searched for guru-held Brazilian stocks. The most widely held Brazilian stocks by the investing gurus are Petrobras (PBR, PBR.A), Itau Unibanco (ITUB) and Banco Santander Brasil (BSBR).

Petrobras is the most widely held Brazilian stock by the gurus. The ordinary shares are held by 15 gurus and the preferred shares are held by eight gurus. Of the 15 holders of the ordinary shares, five of them started their positions in the first quarter of 2014. Petrobras is one of the largest oil and gas companies in the world. It operates in five business segments: Exploration and Production, Refining, Transportation and Marketing, Distribution, Gas and Power, and International.

The difference between the two classes of shares is that the ordinary shares have voting rights and the preferred shares get priority in dividend distributions. Unlike in the U.S., Brazilian preferred shares trade more in line with common stocks and do not have a call price. PBR is trading at $15.66 with no dividend, and PBR.A is trading at $16.83 with a current dividend yield of 1.30 percent. With Petrobras, by law, the Brazilian government must maintain control and does so with 61 percent of the voting shares. With the government in control, the only reason to buy the ordinary over the preferred shares is if there is a mispricing between the two securities. The ordinary shares are trading at a discount of 7 percent to the preferred shares. That is too much of a discount given the 1.3 percent dividend yield on the preferred shares, and is likely why more gurus hold PBR over PBR.A.

Fundamentally, Petrobras is undervalued based on its price-to-book (P/B) ratio of 0.60. Historically, the stock has traded at a much higher P/B ratio, and its five-year median is $15.40. The stock would be trading at $33.80 at its median P/B ratio. With its declining earnings and book-value per share, the stock is not likely to trade at its median P/B ratio soon, but should revert back to a P/B ratio of at least 1 at some point in time.

Itau Unibanco is held by 10 gurus. Four of the gurus opened their positions in the first quarter of 2014. Itau Unibanco provides various financial products and services in Brazil and internationally. It is the second largest financial conglomerate in the Southern Hemisphere behind Australia & New Zealand Banking Group (ANZBY). The stock seems very expensive with a P/B ratio of 2.01. In normal conditions, bank stocks tend to trade with a P/B ratio between 1.2 and 1.3. The industry mean is 1.24. The stock does look cheap in relation to its earnings per share. The P/E is currently at 11.20. The five-year median P/E for Itau Unibanco is 14.1. If the stock were to trade at that level, the price would be $19.10 per share. According to the GuruFocus DCF Calculator, earnings would need to grow at 7.45 percent to justify its current price. EPS fell to $1.60 in 2013 from $3.10 in 2012, but is now at $2.40 for the trailing 12 months.

Banco Santander Brasil is held by seven gurus. Only one of the gurus, Steven Cohen, opened a new position in the first quarter of 2014. Banco Santander Brasil is a full-service bank in Brazil and operates in two segments, Commercial Bank and Global Wholesale Bank. It is a subsidiary of Spain’s largest bank, Banco Santander SA (SAN). The parent company has offered to acquire the remaining 25 percent stake from minority shareholders. If the deal is accepted by the minority shareholders, they will receive 0.7 shares of Banco Santander for every share of Banco Santander Brasil. Today, the parent company, SAN, is trading for 10.55 per share. That would make BSBR valued at $7.39 per share if the buyout is approved. The stock is trading at $6.97 per share, about a 6 percent discount to the current buyout price. Banco Santander, the parent company, is trading at about fair value with a P/B ratio of 1.20, within the range of the average P/B ratios for bank stocks.

On a lighter note, Goldman Sachs released The World Cup and Economics 2014 Report on May 27. The report says that the World Cup winner outperforms the global market by 3.5 percent in the first month. Goldman Sachs used sophisticated modeling tools to predict the outcome for each of the matches. The resulting champion is Brazil with a 48.5 percent probability of winning. Argentina has the next highest probability of winning at 14.1 percent. In 2010, Brazil had the highest probability at 26.8 percent, Spain was second at 15.7 percent, and the Netherlands was third at 14.9 percent. Spain defeated the Netherlands in the 2010 World Cup. Unfortunately, the bounce in the World Cup winner’s markets are short lived. Their stock market tends to underperform by 4 percent over the year following the final. Of course, the World Cup market data is most likely spurious correlation, but it is fun to look into.

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